Much too early to let down inflation guard: Moskow

Although risks have diminished, Fed may have to hike again

WASHINGTON (MarketWatch) -- It is way too early for the Federal Reserve to consider relaxing about the outlook for inflation, even though the risks of higher prices have become diminished in recent months, said Michael Moskow, the president of the Chicago Federal Reserve bank on Friday.

"It is much too early to say that inflation is no longer a concern," Moskow said in remarks prepared for delivery at the University Club of Chicago.

Moskow is a voting member of the FOMC this year. He has consistently warned about the possible need for further rate hikes ever since the central bank first chose to hold rates steady at 5.25% in August.

Despite Moskow's warning about tighter monetary policy, he voted with the other Fed policy makers to leave rates steady at its last meeting on Jan. 31. With that vote, he failed to follow in the footsteps of Richmond Fed President Jeffrey Lacker, who has also been warning about the need for more rate hikes and dissented in favor of higher rates at the last four FOMC meetings in 2006. Read MarketWatch comprehensive Fed page.

Moskow has announced he is retiring from his post at the Chicago Fed at the end of August. A search is underway for his successor.

In his outlook on the economy in 2007, Moskow said he sees "the economy with some solid underlying momentum behind it and inflation running too high."

Moskow said the economy seems on more solid ground that it did late last year.

"The major downside risks to the growth outlook have diminished," Moskow said.

The Chicago Fed president said he expected the housing sector to stabilize over the course of the year. He said he was not persuaded to alter this optimism even though the Commerce Department reported a sharp drop in housing starts in January. See full story.

Consumer spending will be supported this year by healthy labor markets, lower energy prices and solid productivity trends, he said.

Business investment should also continue this year, Moskow said.

Although manufacturing has been weak recently due to an inventory overhang, Moskow said he doubted there will be significant cuts in production moving forward.

On inflation, Moskow said that the low unemployment rate raises some concern that labor market conditions are too tight and may foster rising labor costs and prices.

"But we are not at that point yet," he said.

"I've heard more than a few stories of shortages of highly skilled workers, but thus far the increases in overall compensation have been relatively moderate," he said.

Moskow noted that he has seen "some lessening of inflation risks in recent months."

"But as I have noted, I expect the economy to continue to operate at a high level relative to its potential, which could eventually lead to the emergence of increased inflationary pressures," Moskow said.

He added that he was concerned that inflation might not decline into his "comfort-zone" of 1%-2% as measured by the core personal consumption expenditure index.

The core PCE price index increased 2.3% in 2006, up from 2.1% in 2005.

"If actual inflation does not show clear enough signs of returning to the center of the range I associate with price stability, there is a danger than expectations of inflation could run too high, which would likely be a self-fulfilling prophesy," he said.

Moskow said the risk of inflation remaining too high is greater than the risk of growth falling too low. "Thus, some additional firming of policy may yet be necessary to address this inflation risk," he said.

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